When times get tough more and more people are turning to payday loans. A payday loan is a simple concept: You borrow money and pledge your next paycheck to repay the loan. That doesn’t sound too bad if you’re in a tight spot, right? Unfortunately the interest rates and fees on these types of loans are obscenely high. It is not uncommon to find that the interest rate is over 100% on an annual basis!

Payday lenders are popping up everywhere and for good reason. They see this as providing a service to those who are desperate for money. They are able to charge outrageous interest rates because people who really need the money aren’t concerned about interest rate, just that then can pay whatever needs to be paid. This is a recipe for disaster.

Getting Caught on a Treadmill

The biggest problem when people use these services is that they can become trapped on a treadmill. The first time you need to advance $500 from your paycheck might be because your rent is late. That’s fine and you get the money to pay the rent. But the problem is that when your next paycheck comes and that money (plus fees and interest) comes out you find yourself unable to pay another bill. So what do you do? Most go back to the payday lender and renew the loan. This begins to become a regular cycle and before you know it you are relying on this payday loan every paycheck just to keep up and all the while you are paying significant interest and fees.

There Are Options

Unfortunately when money is tight you are in a position where you feel you need to resort to one of these loans. Before taking any action simply sit down and think about why you need the money in an objective manner. Is it just one bill that is coming due that you don’t have money for? Maybe a utility bill or even car payment? If so, things aren’t as bad as they seem.

First, check with the company directly to see if there are options for payment. Utility companies are typically very helpful when it comes to making payments. Most electric companies will provide alternative payment options to help you get on track. Another thing to consider is to read the fine print and see what the grace period and/or late fees are. You will find that many utility companies and even some banks allow payments to be made within a grace period after the actual due date. Also check to see what the late fees are. In most cases they will be far less than just the fee alone to get a payday loan.

I had a situation last year where we completely forgot to pay our electric bill. It totally slipped my mind until the next month’s statement came. To my surprise, the late fee for not paying on time was $2.50. That’s it! And since we then submitted our payment and it was still not over 30 days late it was not reported to the credit bureaus. If you are tight with money and may be faced with a bill being late, check to see what it could cost to be late (not late enough to trigger a negative credit remark). You may find that even if you’re a few days late with your payment you may fall within a grace period or have a late fee that is a faction of what you’d owe with a payday loan.

Of course this doesn’t apply to something such as a mortgage or rent where you could be put into a bad situation. In these cases it is best you talk with your lender or landlord and let them know your situation. A proactive approach can go a long way in resolving issues. It also may not work very well with credit card payments as well. Oftentimes the late fee for a credit card payment can be just as steep as some payday loans, so be careful in deciding what to pay.

The Importance of Emergency Funds

Earlier I talked a bit about having some emergency savings set aside and I realize that if you are to a point where you are considering payday loans just to keep up that you probably don’t have much money set aside in savings. That’s ok, but you should consider starting something small. For instance, try to have $100 saved up. Take back all that loose change, if your grandma sends you $20 for your birthday save that. At least try to scrape together enough to pay one of those emergency bills that is coming due and could be late. It doesn’t have to be a lot, but having something set aside even if it only covers your cell phone bill or gas to get you to work and back for a week will help in a jam. It will reduce the need to resort to very expensive options such as a payday loan.

If saving money isn’t working and your credit is in decent enough shape, try to find an emergency credit card. If you can find one with 0%, great, if not just try to find one with the lowest rate you can. It will clearly be lower than any payday loan would be. If you have to just request a low limit. Maybe $500 or $1,000 tops. Then keep the card locked up or out of your wallet and realize it is simply for an emergency when you would otherwise seek a payday loan. Obviously this could be difficult if your credit is already in shambles but even a card with $500 available on it and a 25% interest rate will keep you from making what could be a very costly payday loan mistake.

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

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